(EDITORIAL from the Korea Times on Nov. 5)

Foreign Reserves
It's Time to Ensure Flexible, Effective FX Management

Policymakers, bankers and businesspeople have tended to think that the nation
should hold as much foreign exchange reserves as possible. This thinking is based
on their experience of the 1997-98 Asian financial crisis. Since then the Bank of
Korea has been engrossed in replenishing the reserves in a move to avoid a
recurrence of the crisis.

As South Korea successfully tided over the currency turmoil in a short period,
the nation's foreign reserves surged to $102.8 billion at the end of 2001. The
sum surpassed the $200-billion mark for the first time in 2005. And it hit an
all-time high of $264.2 billion in March 2008. But the amount fell to $200.5
billion last November amid the global financial and economic crisis, forcing the
country to strike a currency swap deal with the United States.
The reserves are now approaching the previous record level. They totaled $264.1
billion last month, up $9.9 billion from September. They also reported the eighth
consecutive monthly increase which was attributed to the nation's soaring current
account surplus. The upward march was also made possible by the central bank's
purchase of dollars to stem the further rise of the Korean won against the
greenback.
It is good to see the replenishing reserves. South Korea is the world's
sixth-largest holder of foreign currencies after China, Japan, Russia, Taiwan and
India. And the holdings are likely to exceed $270 billion this month. It seems
that the nation will no longer be worried about a shortage of hard currencies,
although some skeptics still urge the authorities to increase the reserves to far
more than $300 billion.
Now, we have to ask a question: what is the optimal level of the foreign exchange
holdings? Some say, ``The more, the better." Of course, it is important to have
enough reserves to better prepare for a potential crisis. But we need to
recognize that more foreign reserves will bring more financial burden to the
economy. The central bank's continued buying of dollars will inevitably lead to a
surge in the monetary supply. This is feared to increase inflationary pressure,
resulting in a hike in interest rates. If they issue bonds to absorb excess
liquidity, the authorities should shoulder the interest payment burden.
Besides, increasing foreign reserves could bring about the problem of an
opportunity cost. The central bank has to give up possible profits by pooling
financial resources as a defense against a potential default. That's why foreign
reserves are often likened to a double-edged sword. Their shortage may invite a
crisis, while their excess may cost the nation its wealth.
Therefore, the country should try to ensure the flexible and effective management
of its foreign reserves. It is necessary to diversify the composition of the
reserves by increasing the proportion of the euro and the Japanese yen, while
reducing the dollar holdings to avoid losses arising from the weaker U.S. unit.
The nation is also advised to curtail its short-term foreign debts so that it can
avoid exposure to external risks. Most of all, it would be better to improve the
nation's international credibility, which would enable South Korea to fare well
with less foreign reserves.
(END)